spring 2004 cagny meeting how do rating agencies determine insurance company ratings john andre vice...
TRANSCRIPT
Spring 2004 CAGNY Meeting
How do Rating Agencies Determine Insurance Company Ratings
John Andre Vice PresidentProperty/Casualty RatingsJune 3, 2004
Discussion Topics
The Rating Process
Importance of Capital Adequacy
Best’s Evaluation of Capital
Current & Future State of the Market
A.M. Best Mission Statement
To perform a constructive and objective
role in the insurance industry toward the prevention and
detection of insurer insolvency
Best’s Rating Evaluation— Rating Components
Balance SheetStrength
Operating Performance
Business Profile
Operating Issuer Credit Rating
Financial Financial
StrengthStrength
RatingRating
DebtDebt
RatingsRatings
Balance Sheet StrengthBalance Sheet Strength
Operating PerformanceOperating Performance
Business Business ProfileProfile
ManagementManagement
Rating ConsiderationsSuccess Factors
Balance Sheet Strength: Rating Evaluation
Leverage Capital structure / holding company Quality & appropriateness of
reinsurance program Adequacy of loss reserves Quality and diversification of assets Liquidity Risk-adjusted capital (BCAR)
Operating Performance: Rating Evaluation
Profitability Revenue composition Business plan & expectations Risk appetite Management experience & objectives
Business Profile: Rating Evaluation
Market risk Competitive market position Spread of risk Event risk Regulatory risk
Best’s Rating Perspective
Capital Strength is Most Important Sustained, Stable Operating Profitability
Ensures Future Strength Well-Diversified, Strong Business Profile
Ensures Stability Considerations
Claims Tail Excess Capital Strength Minimum Capital Requirements
Why Market Profile and Operating Performance?
Leading Indicators of the Future Balance Sheet
Fina
ncia
l Str
engt
h Strong Market Profile and Operating Performance
Weak Market Profile and Operating Performance
Date of last
balance Sheet
Today Time
~4~
BCAR Considerations: Many Issues
Leverage Capital structure / holding company Quality & appropriateness of reinsurance
program Adequacy of loss reserves Quality and diversification of assets Liquidity Profitability Growth Rate
Fundamentals of A.M. Best’s Capital Adequacy Model
Interactive
Dynamic
Consolidated Approach
Capital Factors Calibrated to a 1% EPD
Reserve and Premium Adequacy
Correlation and Diversification of Risk
One of three parts of an integrated rating approach
Economic SurplusReported Surplus (PHS)Equity Adjustments:
Unearned PremiumsLoss ReservesAssets
Debt Adjustments:Surplus NotesDebt Service Requirements
Stress Test Adjustments:Future Operating LossesPotential Catastrophe Exp. Other
Economic Surplus (APHS)
Net Required CapitalGross Required Capital (GRC):
(B1) Fixed Income Securities(B2) Equity Securities(B3) Interest Rate(B4) Credit(B5) Loss and LAE Reserves(B6) Net Premiums Written(B7) Off-Balance Sheet
Covariance Adjustment
Net Required Capital (NRC)*
BCAR Ratio = Economic Surplus / Net Required Capital
*NRC= (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² +B7
BCAR Model — Structural
Overview
Calculation of BCAR Score
Company BCAR Score = APHS / NRC
APHS = Adjusted Policyholder Surplus NRC = Net Required Capital
BCAR > 100 ==> Secure Capitalization
B1 & B2 Investment Risk
Fixed Charges applied to Assets 100% Charge to Non-PC Affiliates Asset Concentration Charge
B3 Interest Rate Risk
Stress Tests Exposure To a Rise in a 120BP Interest Rates
Liquidity Risk During the Year Annually Mark Bonds to Market in APHS Impact of Short-Term Cash Need Considers All Assets
B4 Credit Risk
Other than Invested Assets Reinsurance Charge
Charge Based on Quality Additional Dependence Charge
B5 Reserve Risk
Statutory Discount Treated as Deficiency Reserves Adjusted for Adequacy & Disc. Reserve Equity Included in Adj. Surplus Risk Factors
Industry By Line Company Stability Size Reinsurance Impact
Growth Charge Diversification Credit
B6 Premium Risk
Based On Net Written Premium Risk Factors
Industry By Line Company Profitability Size Reinsurance Impact Underwriting Cycle
Growth Charge Diversification Credit
Frequently Made Adjustments
Reserve Adequacy (Core & A&E) Reinsurance Charges Catastrophe Exposure Affiliated Charges Stop Loss Reinsurance Reinsurance Terms Loss Sensitive Business Projected Capitalization
Calculation of BCAR Score
Company BCAR Score = APHS / NRC
APHS = Adjusted Policyholder Surplus NRC = Net Required Capital
BCAR > 100 ==> Secure Capitalization
Minimum Capital Requirements
Rating Level BCAR ScoreA++ 175
A+ 160
A 145
A- 130
B++ 115
B+ 100
B/B- 80
C++/C+ 60
Exceptions Based on Overall Analysis
Key P/C Financial Indicators
2002 2003NPW Growth (%) 14.9 9Surplus Growth (%) -1.4 22.2Combined Ratio 107.4 100.1
Inv. Income Growth (%) 2.9 0.9Investment Yield 4.9 4.3POI to NPE (%) 2.2 8.8After-Tax ROS (%) 3.1 9.5
NPW to Surplus 1.3 1.2
Affect on P/C Combined Ratio
2002 2003
Combined Ratio (Reported) 107.4 100.1
Less: Catastrophe Losses 1.6 3.2Less: A&E Losses 2.4 1.8Combined Ratio (Normalized) 103.4 95.1
Combined Ratio (Accident Yr) 99.4 93.3
Financial Trends– Commercial Lines
2002 2003Change in NPW (%) 19.9 10.5Change in Surplus (%) 19.9 21.8Combined Ratio 107.7 101.8Change in Net Inv. Income (%) 0.6 1.1Investment Yield 5.0 4.2
After-tax Return on Surplus (%) 6.6 9.9
NPW/PHS (Reported) 1.3 1.3
Financial Trends – Personal Lines
2002 2003Change in NPW (%) 11.5 11.0
Change in Surplus (%) -5.6 18.3Combined Ratio 104.8 98.3Change in Net Inv. Income (%) -4.5 0.8Investment Yield 4.5 4.0
After-tax Return on Surplus 1.0 10.1NPW/PHS (reported) 1.5 1.3
Financial Trends – Reinsurance
2002 2003Change in NPW (%) 20.1 5.4Change in Surplus (%) 4.7 33.9Combined Ratio 122.9 100.4Change in Net Inv. Income (%) 38.0 -8.3
Investment Yield 5.4 4.3
After-tax Return on Surplus 1.4 6.3NPW/PHS (reported) 0.6 0.5NPW/PHS (Excl National Indemnity) 1.0 1.0